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Growth stocks are typically defined as companies with higher-than-average earnings growth and a high return on equity (ROE). Unlike income stocks, they focus on reinvesting funds into the business rather than rewarding shareholders.
Identifying stocks with decent growth potential can be more difficult than income stocks, as they don’t offer a strong indication of returns, like dividends. Choosing the best ones requires an extensive understanding of global market trends and careful analysis of company financials.
Recently, London Stock Exchange Group announced it was working with Anthropic to bring financial data access to its artificial intelligence (AI) platform, Claude. That gave me an idea: could AI pick decent growth stocks?
I decided to find out.
Testing the field
To get a more varied answer, I asked several AI platforms. Since ChatGPT’s the best-known, I started there.
Shockingly, it decided to go all in on semi-conductor chips, picking Nvidia, AMD and ASML. While they may all be decent choices, picking three stocks in the same industry goes against the number-one rule of smart investing: diversification.
Next, I gave Claude a go. Its answer was arguably even riskier: Palantir, ARM and Coinbase. The first two have eye-wateringly high valuations and the second relies heavily on the success of crypto. No thanks.
Exasperated, I tried one more time, with Gemini. Seemingly stuck in the same trend, it suggested Nvidia, Super Micro Computer and Palantir.
So I gave up. Is AI biased towards semi-conductor chips? Quite possibly.
None of the above companies are necessarily bad picks. But at best, they’re too obvious, and at worst, they lack diversification and a long-term investment thesis.
At the end of the day, I came to a realisation: AI was unlikely to tell me anything I couldn’t find with a quick Google search.
So what’s a good growth stock?
That depends on who one asks. Risk-tolerant day traders looking to make a quick buck might agree with AI’s picks. But I think smart investors with a long-term outlook should be more discerning.
More conservative investors may want to consider one of Warren Buffett’s long-term holdings, Mastercard (NYSE: MA).
The card company’s shown mixed performance recently, with its share price up around 9% over the past year. However, the longer-term picture looks far more impressive, up 445% over the past decade – an annualised return of about 18.5% a year.
The company’s fundamentals remain strong, boasting a ROE of 185.7% and a net margin of 45.2%, highlighting its exceptional profitability. Its valuation’s fairly reasonable for a growth stock, trading at a forward price-to-earnings (P/E) ratio of around 33.
However, emerging fintech challengers could pose a risk and steal some of its market share. The card payments market’s already saturated, so new customers must be retained.
Still, Mastercard seems unlikely to fade away any time soon given its entrenched role in everyday commerce.
Bottom line
Growth stocks can be exciting, but they’re not for the faint-hearted. Diversification’s key to reducing risk and slow, steady growth’s usually better than rapid, short-term growth.
Establishing a long-term mindset focused on quality and sustainable earnings growth is usually better than chasing the next hot tip from AI.
This story originally appeared on Motley Fool
